Tracking the Low-Volatility Anomaly Across Behavioral Space

Abstract

In his popular guide to asset allocation, neurologist-turned-financial-analyst William J. Bernstein offers a bit of jarring advice to investors: “Good companies are usually bad stocks; bad companies are usually good stocks.”¹ Bernstein’s practical prescription stems from an academic insight: “Growth opportunities are usually the source of high betas.”² In principle, these high betas should impart higher risk and higher returns to growth stocks: “[B]ecause growth options tend to be most valuable in good times and have implicit leverage, which tends to increase beta, they contain a great deal of systematic risk.”³ Nevertheless, even though “growth options hinge upon future economic conditions and must be riskier than assets in place,” the historical pattern cuts in the opposite direction: “[G]rowth stocks earn lower average returns than value stocks.”⁴ From these observations flows Bernstein’s advice to the individual investor: “Favor a value approach in your stock and mutual fund choices.”⁵